Capital asset pricing model (CAPM)

An economic theory that describes the relationship between risk and expected return, and serves as a model for the pricing of risky securities. The CAPM asserts that the only risk that is priced by rational investors is systematic risk, because that risk cannot be eliminated by diversification. The CAPM says that the expected return of a security or a portfolio is equal to the rate on a risk-free security plus a risk premium multiplied by the asset's systematic risk. Theory was invented by William Sharpe (1964) and John Lintner (1965). The early work of Jack Treynor is was also instrumental in the development of this model.

Capital Asset Pricing Model

A model that attempts to describe the relationship between the risk and the expected return on an investment that is used to determine an investment's appropriate price. The assumption behind the CAPM is that money has two values: a time value and a risk value. Thus, any risky asset or investment must compensate the investor for both the time his/her money is tied up in the investment and the investment's relative riskiness. This compensation must be in addition to the risk-free rate of return. There are a number of variations on the CAPM, notably the multifactor CAPM and the two-factor model. The CAPM is calculated according to the following formula:

ra = rf + Betaa(rm - rf)

where:

ra is the asset price,
rf is the risk-free rate of return,
Betaa is the risk premium, and

rm is the market rate of return.

capital asset pricing model

a model that relates the expected return on an ASSET or INVESTMENT to its risk. Assets that show greater variability in their annual returns generally need to earn higher expected average returns to compensate investors for the variability of returns. See RISK AND UNCERTAINTY.

Collins Dictionary of Economics, 4th ed. © C. Pass, B. Lowes, L. Davies 2005

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References in periodicals archive

Multifactor Capital Asset Pricing Model and the Jordanian Stock Market (Doctoral dissertation, Walden University).

TWO-PASS MODEL OF CAPM: EVIDENCE FROM PAKISTAN STOCK EXCHANGE

Hill and Fairley (1979) found that "fair" profit rates determined by the Capital Asset Pricing Model were close to historical profit rates than to traditional rule-of-thumb profit rates used in regulation.

UNDERWRITING PROFITS IN PROPERTY AND CASUALTY INSURANCE: EQUILIBRIUM VERSUS ACTUAL

Kayo, 2014, "The Earnings/Price Risk Factor in Capital Asset Pricing Models." Annual Conference, Port of Spain, Trinidad and Tabago.

A five-factor asset pricing model: Empirical evidence from Egypt

A capital asset pricing model with time-varying covariances.

Testing the non-parametric conditional CAPM in the Brazilian stock market/Avaliacao do CAPM condicional nao parametrico no mercado de acoes do Brasil

3.1 The Inter-temporal Capital Asset Pricing Model (ICAPM)

CAPM Intertemporal: um teste empirico utilizando dados brasileiros

The Capital Asset Pricing Model (CAPM), Short Sell Restriction and Related Issues, The Journal of Finance, Vol.

CONSIDERATIONS REGARDING METHODS AND VALUATION MODELS OF EQUITY COST OF THE COMPANIES

Still, higher expectations are placed upon the Capital Asset Pricing Model (CAPM) and the Arbitrage Pricing Theory (APT).

Dynamics of capital markets and its impact on the cost of equity/Kapitalo rinku dinamika ir jos itaka nuosavam kapitalui

Markowitz's optimization approach is the basis of possibly every SAA and the expected return forecasts used as inputs in the SAA development process are derived from the Capital Asset Pricing Model (CAPM).

Column on SAA: Simply Awful Allocations?

Since no beta factor yet exists for this, let's use a proxy figure based on the plastics industry to approximate the risk and hence (using the capital asset pricing model) the adjusted cost of equity of the new project.

Paper F3 financial strategy: if your company is considering an investment project in a completely new industry to it, beware of using its current WACC to discount the post-tax operating cash flows of that project

Under the framework of Fisher's hypothesis and the real capital asset pricing model, we investigated stumpage prices' ability to hedge against inflation in 12 US southern timber regions using Timber Mart-South data.

Can timber hedge against inflation? An analysis of timber prices in the US South